Guest Post: Global Grand Policy Failure: Liquidity Traps And Financial Black Holes

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

Global Grand Policy Failure: Liquidity Traps and Financial Black Holes

"We are all Keynesians now," indeed. Keynesian policies have pushed the global economy into a financial black hole.

What we are experiencing is Grand Policy Failure on a global scale, a failure best understood by examining liquidity traps and the Keynesian plummet into Financial Black Holes.

What is a liquidity trap? Here's Wikipedia's definition:

The liquidity trap, in Keynesian economics, is a situation where monetary policy is unable to stimulate an economy, either through lowering interest rates or increasing the money supply. Liquidity traps typically occur when expectations of adverse events make persons with liquid assets unwilling to invest.

Here's what that means in the real world. I have $100 in liquid assets, i.e. cash, I saved from my income. I could leverage that by borrowing $1,000 at low interest and devoting the $100 to service that new debt ( i.e. make a future monthly payment), but since my future income is in doubt, I have no desire to take on more debt, even at zero interest. How do I know if my income will enable me to pay back the principal?

I could spend the $100 on discretionary purchases, but since I have everything I need to get by and my future income is doubtful, I prefer the security of savings over the marginal return of owning more gewgaws.

I could use it to hire an assistant (presuming I'm self-employed or in business), but since revenues have been unpredictable, I'd rather work a few extra hours myself and keep the $100.

I could spend the $100 on some new software that might make me more productive, but why bother when business is at best flatlined and at worst, in a freefall?

That's a liquidity trap: those with cash and the ability to borrow have no desire to either spend or invest in new employees or business assets. Their cash (liquidity) is "trapped" in the sense they have no desire or need to spend it or invest it.

In standard Keynesian economics, the only thing holding back a tide of spending and investing is lack of faith in future growth.

This is of course wrongheaded. Keynesianism is blind to the black hole of debt: at a certain threshold (event horizon), the ability and/or willingness to borrow more vanishes. No amount of monetary easing or shoveling new money into banks can spark new debt and spending.

Keynesianism is also blind to the necessity of debt renunciation/forgiveness: the key to freeing up new spending and investment is not shoveling more liquidity into the system, it's blowing off all the bad/impaired uncollectible debt in the system, wiping out borrowers and lenders alike (recall that one man's debt is another man's asset).

That would mean wiping out the "too big to fail" banks, and for some reason the Keynesian cargo-culters (Krugman, Reich et al.) never once propose the renunciation of impaired debt as part of their "solution."

Keynesians also fail to see the black hole of delegitimization: one reason why nobody wants to spend or invest is the credibility of the nation's financial institutions has vanished into the black hole of lost legitimacy.

Now that institutional credibility has fallen below this critical threshold, it cannot be recovered without deep structural transformation that includes severely limiting the political and financial power of Wall Street and the "too big to fail" banks.

Since that's never on the Keynesian agenda, what we have instead is three failed policies, not just in the U.S. but globally. Finding a Prescription for the U.S.'s Money Trap: Three fixes to the "liquidity trap" (

One, the classic Keynesian prescription is for the government to borrow (after all, rates are low and savings idle) and spend to create demand and jobs.


Two, Lars Svensson, now deputy governor of the Swedish central bank, sees one "foolproof way of escaping from a liquidity trap"—devalue the currency. "This will jump-start the economy and escape deflation."


Three, the interest rate that matters in the economy is the sticker-price rate adjusted for inflation. So some economists argue that the way out of the trap is for the Fed to convince everyone it's going to create more inflation. If inflation goes up and interest rates don't, then the inflation-adjusted interest rate falls, and that will give people cause to borrow and spend. Incomes rise with inflation, debts wouldn't, and they'd be easier to pay off.

All three Keynesian policies have been tried, and all three have failed completely. The massive "shovel-ready" fiscal stimulus caused a minor blip up in activity, but it did not spark any regeneration of borrowing and spending. All it did was enable further deleveraging as consumers and businesses struggled to pay down their crushing debt loads.

As for devaluing the currency, the Fed's policies devalued the U.S. dollar 32% from the early 2000s, and 17% from 2008. Rather than spark a boom of spending and investment, this massive devaluation sparked a dramatic loss of purchasing power which households experience as high inflation.

No nation ever prospered in the long-term by devaluing its currency. Devaluation is just another Keynesian "quick fix." Borroing 40% of Federal spending didn't "fix" what's wrong with the economy? Then borrow 50%. That devaluation wasn't enough? Then takes the dollar down another 10%. These are the policies of debt-junkies, not legitimate long-term growth based on capital formation and productive investment.

As for inflation being the "solution," the Keynesians forgot that vast, systemic labor surpluses mean that wages and incomes don't rise with inflation, except for the top 10%. So rather than force people to spend, spend, spend, that higher inflation so beloved by Keynesians has sapped the purchasing power of the bottom 90% of households which have seen their incomes stagnate or decline for years.

Solution 1: Central State fiscal stimulus: failure.

Solution 2: central bank-induced currency devaluation: failure.

Solution 3: central bank-induced inflation: failure.

Every textbook Keynesian solution to escape the black hole of liquidity entrapment has been tried on a grand scale, and failed on an even grander scale.

The solution is simple: renounce/write down all impaired debt, wipe out the "too big to fail" banks, and restrict the reach and political power of the remaining banks and Wall Street.

Until we're willing to do that, then the liquidity trap will remain a black hole that the economy cannot possibly escape.

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Debtless's picture

I'm sorry did i miss them handing everyone in the US a check for $10,000?

goldfish1's picture


"We ain't got no jobs, no money. We heard that other people were getting things for free, so why not us?" asked E.Nan, a young man in a baseball cap in Hackney, a multi-ethnic area in east London and one of the worst-hit areas.

spanish inquisition's picture

So I wonder what the governemnt thinks about Twitter revolutions now?

nope-1004's picture

Add Larry Summers to that camp of Keynesian IDIOTS.  Old, out of touch, caught in a rut Larry Summers needs to freakin' go away.  Can't stand looking at the moron on TV spout about "economic policy" when he lived during a 60 year cycle of illusionary money policy.

Even Reagan had it wrong, but we're just seeing the results now.


mick_richfield's picture

Don't stare into the Palantir.  You don't know who's in charge of the programming.

Sancho Ponzi's picture

Debtless said: 'I'm sorry did i miss them handing everyone in the US a check for $10,000?'

About 20k per taxpayer would pretty much erase the personal non-collateralized debt, but the boyz have to keep the debt slaves in their place. The majority of people would use the cash to pay down debt, and a few would buy big screen televisions, hookers and coke, so the price for those items would likely rise. 

DosZap's picture

That will simply cause it to go underground, and it will come back far more violent.(this is when the HARD cores get together.)

Until you rationally deal w/the issues,this would take it to the next level.

Let them declare it, and wait till a few are beaten, or killed.

You ain't seen nuthing yet.

CH1's picture

About the only way they'll get spending going.

f16hoser's picture

All this while the CIA murders more US Service members so they can justify the WOT. Good luck cutting the Pentagon budget.......

High Plains Drifter's picture

oh, do you mean when they helped their double agent taliban people setup the seal team 6 people, the same ones that participated in that so-called "raid" on "bin laden"  which probably didn't happen anything like was told to us, but nevertheless, they had some loose ends running around, some loose ends that needed to be taken care of. such is life in the spook and black ops community. whatever it takes, whoever it is that needs wacking.

itiswhat1tis's picture

loose ends?  explain what you mean here, as none of the seals who died in that crash were part of the bin laden raid.  

High Plains Drifter's picture

that is not what i have read. loose lips sink ships. sometimes witnesses die. does it disturb you that your own military can do this to its own people? hmmm? also please don't bark orders at me sir. i am not in the military anymore and i don't like taking orders from anyone....:)

youngman's picture

Always brothers in Arms....Always

chinaguy's picture

At least the War on the Middle Class is going well.

oogs66's picture

sad to admit, but that made me laugh!

hedgeless_horseman's picture

Oceania has always been at war with The Middle Class.

fuzed's picture

"So what happened to the stimulus? Much of it consisted of tax cuts, not spending. Most of the rest consisted either of aid to distressed families or aid to hard-pressed state and local governments. This aid may have mitigated the slump, but it wasn’t the kind of job-creation program we could and should have had. This isn’t 20-20 hindsight: some of us warned from the beginning that tax cuts would be ineffective and that the proposed spending was woefully inadequate. And so it proved.


So let’s summarize: The economy isn’t fixing itself. Nor are there real obstacles to government action: both the bond vigilantes and structural unemployment exist only in the imaginations of pundits. And if stimulus seems to have failed, it’s because it was never actually tried. "



goldfish1's picture

that the proposed spending was woefully inadequate


Spending? No the bulk of the money went right to the banks and corps and there it remains.


digalert's picture

The Bernank should be in prison for treason!

f16hoser's picture

Ben and Alan should be cell mates.....

oogs66's picture

that would be the start of some actual justice

High Plains Drifter's picture

the mudhole stomping on silver continues on today.  blythe, you are going to get yours one day...........

goldfish1's picture

What happens when something is repressed too long and too hard?

LFMayor's picture

Nothing good.  Example: around 60 years ago a bunch of geeks got together and repressed some refined uranium.

Derpin USA's picture

tl;dr Keynesian stimulus cannot work when it simultaneously extends deleveraging.

Peter K's picture

Some call it Keynsianism, others Marxism, but at the end of the day, it's all still a huge heap of shit.


Oligarchs Gone Wild's picture

Beliefs.  Much like religion.  Our civilization is approaching a cognitive ceiling that we cannot get through.  Gridlock as it's refered to Rebecca Costas book. 

Rather than approaching things differently, it feels better to resort to religion and what temporarily "got us through the challenges of the past" for short term relief.  It feels good and buttons complex problems up nicely by resorting to Keynsianim and Marxism explanations and solutions, no differently than throwing virgins into the volcanos or making human sacrfice did to anchient civilization that ran up against it's own unsolvable mysteries.

In order to smash through this barrier, the leaders and benefactors of these old religions must either step aside or be made to step aside so civilization can evolve beyond this religion of debt and ponzi madness.

disabledvet's picture

Watch that greenback strengthen now that interest rates are plunging world wide and defaults start cascading. MARS ATTACKS!

Mercury's picture

The massive "shovel-ready" fiscal stimulus caused a minor blip up in activity, but it did not spark any regeneration of borrowing and spending.

That was mostly bullshit actually.  The money went to big government pet programs and state governments to plug holes and cover existing liabilitiies.  So, to be fair to Keynesianism...we don't know what the outcome of real infrastructure stimulus would have been. 

 Is there a new bridge in your town?

LFMayor's picture

True dat.  Near me, they re-surfaced about 9 miles of shoulder along the highway.  I shit you not.  Some asshole senators brother in law made a killing, I'm sure.

AbandonShip's picture

Yeah man, come to Chicago or any other city in IL near Chicago and you won't believe the amount of shovel-ready projects going on right now.  They're tearing down and rebuilding every bridge/over-pass whether it needs maintenance or not. Obama knows how to take care of his supporters.

Mercury's picture

Well I can believe that but in my neck of the woods and most places I've been I see a lot of these:

...and not much shovelin'

hedgeless_horseman's picture

This is an excellent Reader's Digest article on why we are here, today.  Clearly states the problem, and proposes a solution.  Refreshing.  Good stuff to forward on to your local politician.

DosZap's picture


If they COULD read, it would work.

IF they gave a shit, it could work.

It's all for one, and one for all....................UP ^ There....................

hedgeless_horseman's picture

...local politicians.

Know your sherriff, constable, mayor, etc., on a first name basis.  They are wondering what the hell is going on, too.  An article like this one may be appreciated.

gwar5's picture


Plus, the Keynesian multiplier efect, ala Romer, is not working because the national debt is overwhelming any stimulus effect, requireing exponentially greater "stimulus"  to get the same results as before. Hence, Krugmans call for more and more.

Each sequential Kenyes stimulus over the decades has acheived less and less actual stimulation of the economy because of the growth of the national debt.

dexter_morgan's picture

Krugman is a giant effing idiot.

Deepskyy's picture

Cramer keeps screaming THIS ISN'T 2008!

Well no shit buddy, in 2k8 all the lies came to a head, and things got ugly fairly quickly, and we were told there would be tanks in the streets if we didn't "save the banks."

This is 2011, and we are now dying of cancer.  It is a slow and agonizing process, with some good days and some really bad days, until one day you end up in the ICU hooked up to a mass of machines trying to extend your life for another month or so and you still die anyway.

shargash's picture

All it did was enable further deleveraging as consumers and businesses struggled to pay down their crushing debt loads.

This is not a failure. This is the point. A Keynesian (which I am NOT) would argue that if we enable enough deleveraging, then the crushing debt burden would be releaved, and we would escape the liquidity trap.

goldsaver's picture

A Keynesian (which I am NOT)


For a minute there I read a Kenyan not Keynesian... Thought you were talking about TOTUS

snowball777's picture

"'To dig holes in the ground', paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services. It is not reasonable, however, that a sensible community should be content to remain dependent on such fortuitous and often wasteful mitigations when once we understand the influences upon which effective demand depends."